Zero Rated Supply Is neither a Taxable Supply nor an Exempt Supply

In my personal opinion, for the purpose of levy of goods and services tax, supplies mentioned in sub-section (1) of section 16 of the Integrated Goods and Services Tax Act, 2017 (IGST Act), for the reasons given hereunder, are neither taxable supplies of goods or services or both nor exempt supplies of goods or services or both. In this article, I will try to know the taxability of zero rated supply.

Zero rated supply is understood as a supply which attracts zero rate of tax. Section 16 of the IGST Act relates to “Zero rated supply”. The said section runs as follows:–

“16. (1) “Zero rated supply” means any of the following supplies of goods or services or both, namely:—

(a) export of goods or services or both; or

(b) supply of goods or services or both to a Special Economic Zone developer or a Special Economic Zone unit.

(2) Subject to the provisions of sub-section (5) of section 17 of the Central Goods and Services Tax Act, credit of input tax may be availed for making zero-rated supplies, notwithstanding that such supply may be an exempt supply.

(3) A registered person making zero rated supply shall be eligible to claim refund under either of the following options, namely:—

• he may supply goods or services or both under bond or Letter of Undertaking, subject to such conditions, safeguards and procedure as may be prescribed, without payment of integrated tax and claim refund of unutilised input tax credit; or
• he may supply goods or services or both, subject to such conditions, safeguards and procedure as may be prescribed, on payment of integrated tax and claim refund of such tax paid on goods or services or both supplied, in accordance with the provisions of section 54 of the Central Goods and Services Tax Act or the rules made there under.”

In this article, I will also refer to the definitions of certain expressions, provided in section 2 of the Central Goods and Services Tax Act, 2017 (hereinafter referred to as the CGST Act). These expressions and their definitions are as follows:–

‘(47) “exempt supply” means supply of any goods or services or both which attracts nil rate of tax or which may be wholly exempt from tax under section 11, or under section 6 of the Integrated Goods and Services Tax Act, and includes non-taxable supply;’

‘(78) “non-taxable supply” means a supply of goods or services or both which is not leviable to tax under this Act or under the Integrated Goods and Services Tax Act;’

‘(82) “output tax” in relation to a taxable person, means the tax chargeable under this Act on taxable supply of goods or services or both made by him or by his agent but excludes tax payable by him on reverse charge basis;’

‘(108) “taxable supply” means a supply of goods or services or both which is leviable to tax under this Act;’

With approval, the Constitution Bench of the Honorable Supreme Court of India has, in the Commissioner of Hindu Religious Endowments, Madras vs. Sri Lakshmindra Thirtha Swamiar of Sri Shirpur Mutt., judgment dated: 16/04/1954, quoted the following definition of the word “tax”, namely:-

“A tax is a compulsory exaction of money by public authority for public purposes enforceable by law and is not payment for services rendered.”

In view of above quoted definition of the word “tax”, the Honorable Supreme Court has made following observations, namely:-

“This definition brings out, in our opinion, the essential characteristics of a tax as distinguished from other forms of imposition which, in a general sense, are included within it. It is said that the essence of taxation is compulsion, that is to say, it is imposed under statutory power without the taxpayer’s consent and the payment is enforced by law. The second characteristic of tax is that it is an imposition made for public purpose without reference to any special benefit to be conferred on the payer of the tax. This is expressed by saying that the levy of tax is for the purposes of general revenue, which when collected revenues of the State. As the object of a tax is not to confer any special benefit upon any particular individual, there is, as it is said, no element of quid pro quo between the taxpayer and the public authority. Another feature of taxation is that as it is a part of the common burden, the quantum of imposition upon the taxpayer depends generally upon his capacity to pay.”

In view of observations of the Honorable Supreme Court in the case referred to hereinabove, where tax is leviable under a law, person made liable for payment of tax cannot be given option of not paying tax and tax paid by a taxpayer cannot be refunded to the taxpayer or any other individual.

In a GST Law, expressions “taxable supply”, “non-taxable supply”, “exempt supply” and “zero rated supply” are generally used in, or in reference to, the provisions of the law, like, levy of tax, exemption from levy of tax, realisation of tax by taxpayers, admissibility or non-admissibility of input tax credit, issuing of tax invoices, registration of taxpayers, etc.

In view of the provisions of GST Laws, a taxable supply of any goods or services or both is a supply of goods or services or both in respect of which tax is payable, by the supplier or by the recipient of the supply. With certain exceptions, in respect of all taxable supplies, person making the supply is entitled for claiming   benefit of input tax credit in respect of inputs and input services utilised in making the taxable supply.

Sub-section (1) of section 16 of the IGST Act declares certain supplies of goods or services or both as zero rated supply. A zero rated supply is understood as a supply of goods or services or both on which no tax is payable. This is because the supply, being a zero rated supply, attracts zero rate of tax.  In respect of zero rated supply, a person making the supply is, subject to provisions of section 17(5) of the Central Goods and Services Tax Act, 2017 (hereinafter referred to as the CGST Act), entitled for claiming benefit of input tax credit in respect of inputs and input services utilized in making the supply.

So far as it relates to an exempt supply, for the purpose of the IGST Act, an exempt supply has been defined to mean a supply of goods or services or both which attracts nil rate of tax, or which is wholly exempt from tax under section 6 of the IGST Act. Definition of expression “exempt supply” also includes “non-taxable supply”. In respect of an exempt supply, any tax is not payable. In respect of an exempt supply, person making the supply is not entitled for claiming input tax credit in respect of the inputs and input services which are utilized in making the exempt supply.

Clause (78) of section 2 of the CGST Act, defines the expression “non-taxable supply” as a supply of goods or services or both which is not leviable to tax under the CGST Act or the IGST Act. Such supply may be a supply of alcoholic liquor for human consumption, petroleum crude, high speed diesel, motor spirit (commonly known as petrol), natural gas or aviation turbine fuel. On supply of such goods, tax cannot be levied under any of the GST Laws. However, by virtue of provision of sub-section (2) of section 16 of the IGST Act, where a person makes export supply of these goods or a supply of these goods to a Special Economic Zone unit or to a Special Economic Zone developer, he is entitled for claiming benefit of input tax credit in accordance with the provisions of the said provision.

“Output tax” is understood as the amount of tax computed on outward supplies on which a supplier is liable for payment of tax. According to the definition of expression “output tax”, provided in the IGST Act, output tax the amount of tax computed in respect of taxable supplies. Had any tax been payable in respect of a zero rated supply, tax payable in respect of zero rated supply should also have been included in the definition of expression “output tax”.  Non-inclusion of tax, in respect of zero rated supply, in the definition of output tax also indicates that tax is not payable in respect of a zero rated supply.

Discussion above reveals that-

(i) zero rated supply is different from a taxable supply because, tax is payable in respect of a taxable supply whereas tax is not payable in respect of a zero rated supply; and

(ii) zero rated supply is different from an exempt supply because, in respect of an exempt supply, person making the supply is not entitled for claiming input tax credit whereas in respect of a zero rated supply, person making the supply is entitled for claiming input tax credit.

For the reasons given here in above, a zero rated supply is neither a taxable supply nor an exempt supply. Important question is that if a zero rated supply is neither a taxable supply nor an exempt supply, then what is the nature of taxability of a zero rated supply. We know that where any tax is leviable under a tax law, it is also payable under the law and where tax is not payable, tax is also not leviable. Section 7 of the IGST Act relates to inter-State supply. Both supplies, which are to be treated as zero rated supply, have been included in sub-section (5) of section 7 of the IGST Act. Sub-section (1) of section 5 of the IGST Act provides levy of tax on inter-State supply. Thus sub-section (1) of section 5 of the IGST Act also provides levy of tax on export supply of goods or services or both as well as on supply of goods or services or both made to a Special Economic Zone unit or Special Economic Zone developer. In view of provisions of section 16 of the IGST Act, tax is not payable in respect the said supplies of goods or services or both. Section 16 of the IGST Act relieves the person making zero rated supplies from obligation of payment of tax, cast by section 5(1) of the IGST Act, in respect of the said supplies.  Dictionary meanings of word “exemption”, according to Oxford Dictionary, are “the action of freeing or state of being free from an obligation or liability imposed on others”. In the legal glossary, published by Ministry of Law and Justice, Government of India, meanings of word “exemption” has been given as “the action of exempting; the state of being exempted; immunity from a liability, obligation, penalty, law or authority”. In view of this, freedom from obligation of payment of tax amounts to exemption from tax in respect of the zero rated supply. For this reason, a zero rated supply is a supply exempt from tax under section 16 of the IGST Act. Zero rated supply made by all persons is unconditionally exempt from tax, and therefore, zero rated supply is wholly exempt from tax.  For the purpose of the IGST Act, definition of expression “exempt supply” includes a supply of goods or services or both which is wholly exempt from tax under section 6 of the IGST Act. In order to distinguish zero rated supply from a supply which is wholly exempt from tax under section 6 of the IGST Act, we can address a zero rated supply as “supply wholly exempt from tax under section 16 of the IGST Act”.

In my personal opinion, definitions of expressions “taxable supply” and “exempt supply” are legally incorrect. Sub-section (1) of section 16 should have been started with a non-obstante clause, like “Notwithstanding anything contained contrary to in any other provision of this Act, following supplies of goods or services or both shall be treated as zero rated supply, namely:–

“(a) export of goods or services or both; or

(b) supply of goods or services or both to a Special Economic Zone developer or a Special Economic Zone unit.”

Alternatively definitions of expressions “exempt supply” and “taxable supply” should have been subjected to provisions of sub-section (1) of section 16 of the IGST Act, or such supplies of goods or services or both, as are covered in any of the zero rated supplies mentioned in sub-section (1) of section 16 of the CGST Act, should have been excluded from definitions expressions “exempt supply”, and “taxable supply”.

Here, I would also like to point out that expression “export of goods” has been defined in section 2 of the IGST Act. In the definition of “export of goods”, concept of supply is missing. Activity of taking of any goods outside India from India has been defined as export of goods. In my personal opinion, in sub-section (1) of section 16 of the IGST Act, in place of the expression “export of goods or services or both”, expression “supply of goods or services or both in the course of export of the goods or services or both out of India, or out of the territory of India, as used in Article 286 of the Constitution, should have been used.

So far as it relates to sub-section (3) of section 16 of the IGST Act, I would like to say that in general, refund of unutilised amount of input tax credit is not admissible. It can be claimed only in specified cases in specified circumstances. Section 16(3) (a) gives right to claim refund of unutilised amount of input tax credit which is related to a zero rated supply. For this purpose, Rule 96A has been made by the Central Government. Sub-rule (1) of said rule run as follows:–

“96A. (1) Any registered person availing the option to supply goods or services for export without payment of integrated tax shall furnish, prior to export, a bond or a Letter of Undertaking in FORM GST RFD-11 to the jurisdictional Commissioner, binding himself to pay the tax due along with the interest specified under sub-section (1) of section 50 within a period of —

(a) fifteen days after the expiry of three months[98, or such further period as may be allowed by the Commissioner,] from the date of issue of the invoice for export, if the goods are not exported out of India; or

(b) fifteen days after the expiry of one year, or such further period as may be allowed by the Commissioner, from the date of issue of the invoice for export, if the payment of such services is not received by the exporter in convertible foreign exchange [or in Indian rupees, wherever permitted by the Reserve Bank of India.”

In some cases, export supply of goods was made either without submitting Letter of Undertaking or beyond the stipulated time. In such cases, proper officers had refused to grant refunds and had asked the taxable persons to pay tax along with interest. When the matter came to the notice of the Central Board of Indirect Taxes and Customs, the said board issued clarifications vide its circular No. F. No.349/47/2017-GST, Government of India, Ministry of Finance, Department of Revenue, Central Board of Excise and Customs, GST Policy Wing, New Delhi, Dated the 15th March, 2018. The circular relates to clarifications on refund related issues. Paragraphs 4, 4.1, 5 and 5.1 of the said circular run as follows:–

“4. Exports without LUT: Export of goods or services can be made without payment of integrated tax under the provisions of rule 96A of the Central Goods and Services Tax Rules, 2017 (the CGST Rules). Under the said provisions, an exporter is required to furnish a bond or Letter of Undertaking (LUT) to the jurisdictional Commissioner before effecting zero rated supplies. A detailed procedure for filing of LUT has already been specified vide Circular No. 8/8/2017 –GST dated 4th October, 2017. It has been brought to the notice of the Board that in some cases, such zero rated supplies have been made before filing the LUT and refund claims for unutilized input tax credit have been filed.

4.1. In this regard, it is emphasised that the substantive benefits of zero rating may not be denied where it has been established that exports in terms of the relevant provisions have been made. The delay in furnishing of LUT in such cases may be condoned and the facility for export under LUT may be allowed on ex post facto basis taking into account the facts and circumstances of each case.

5. Exports after specified period: Rule 96A (1) of the CGST Rules provides that any registered person may export goods or services without payment of integrated tax after furnishing a LUT / bond and that he would be liable to pay the tax due along with the interest as applicable within a period of fifteen days after the expiry of three months or such further period as may be allowed by the Commissioner from the date of issue of the invoice for export, if the goods are not exported out of India. The time period in case of services is fifteen days after the expiry of one year or such further period as may be allowed by the Commissioner from the date of issue of the invoice for export, if the payment of such services is not received by the exporter in convertible foreign exchange.

5.1 It has been reported that the exporters have been asked to pay integrated tax where the goods have been exported but not within three months from the date of the issue of the invoice for export. In this regard, it is emphasised that exports have been zero rated under the Integrated Goods and Services Tax Act, 2017 (IGST Act) and as long as goods have actually been exported even after a period of three months, payment of integrated tax first and claiming refund at a subsequent date should not be insisted upon. In such cases, the jurisdictional Commissioner may consider granting extension of time limit for export as provided in the said sub-rule on post facto basis keeping in view the facts and circumstances of each case. The same principle should be followed in case of export of services.”

In the Letter of Undertaking, taxable persons are required to sign a declaration as follows:–

“5. Declaration –

(i) The above-mentioned bank guarantee is submitted to secure the integrated tax payable on export of goods or services.

(ii) I undertake to renew the bank guarantee well before its expiry. In case I/We fail to do so the department will be at liberty to get the payment from the bank against the bank guarantee.

(iii) The department will be at liberty to invoke the bank guarantee provided by us to cover the amount of integrated tax payable in respect of export of goods or services.”

Subject of circular referred to above is ” Subject: Clarifications of certain issues under GST– regarding “. In the circular it has been clarified that exports have been zero rated, and therefore, benefits of zero rating cannot be denied. If goods have actually been exported even beyond prescribed time or without furnishing Letter of Undertaking, payment of integrated tax first and claiming refund at a subsequent date should not be insisted upon. Time should be extended and delay in furnishing Letter of Undertaking should be condoned. However, I fail to understand that what purpose will be served by granting extension of time for export of goods and what request will be made by the taxable person in his application for the purpose of extension of time. Similarly, where goods has actually been exported without furnishing Letter of Undertaking, what purpose will be served in obtaining the Letter of Undertaking. Actually, all three declarations prescribed in the Letter of Undertaking are irrelevant because they are related to payment and recovery of integrated tax on zero rated supply. Usually, undertaking is accepted in order to secure possible losses. In export cases, where refund is to be allowed before the goods are exported, security may be taken in order to protect possible loss on account of false claim of refund.

No person can be required to pay any amount, and no amount can be collected from a person, as tax if such amount cannot be imposed / assessed as tax under the law, at any time.   The Honorable Supreme Court in M/s Bhawani Cotton Mills Ltd. vs. State of Punjab, judgment dated April 10, 1967, has held as follows:–

“If a person is not liable for payment of tax at all, at any time, the collection of a tax from him with a possible contingency of refund at a later stage will not make the original levy valid.”

The said principle has continuously been followed by the Honorable Supreme Court in other cases, like Steel Authority of India Ltd. vs. State of Orissa & Ors. Etc. Etc., Judgment dated: February 26, 2000, M/s Nathpa Jhakri Jt. Venture vs. State of Himachal Pradesh & Ors., Judgment Dated: March 14, 2000. In respect of a zero rated any amount of tax cannot be imposed or assessed and therefore, person making zero rated supply cannot be asked to pay any amount as tax. It is the amount of tax leviable on a supply which can be paid or collected.

Unless definitions of expressions “exempt supply” and “taxable supply” are amended in the manner suggested above, sub-section (2) of section 17 of the CGST Act is impractical and improper. The said provision runs as follows:–

“(2) Where the goods or services or both are used by the registered person partly for effecting taxable supplies including zero-rated supplies under this Act or under the Integrated Goods and Services Tax Act and partly for effecting exempt supplies under the said Acts, the amount of credit shall be restricted to so much of the input tax as is attributable to the said taxable supplies including zero-rated supplies.”

Here it is to be noted that-

(i) a taxable supply which is also covered under zero rated supply will be added twice in the expression taxable supply including zero rated supply; and

(ii) exempt inter-State supply (inter-State supplies which have been exempted under section 6 of the Act or an inter-State supply of non-taxable supply), which is also covered under zero rated supply, shall remain included in the expression “taxable supplies including zero rated supplies” as well as in “exempt supply”  under the IGST Act.

There are certain other mistakes in sub-section (2) of section 17 of the CGST Act. Wrong claim of input tax adversely effects the revenue receipts. If I am not wrong then I would like to say that input tax credit has not been blocked where inputs and input services are exclusively used in making an exempt supply.

I am also of the opinion that existing definition of expression “taxable supply” is not legally valid for other reasons also. I will like to express my views on this issue in a separate article.

Disclaimer: Except the quoted versions, interpretations made and all other views expressed here are my personal views and are meant only for academic discussion. Readers are advised to follow the provisions of the law and to seek opinion of their legal advisors before acting upon the views expressed here. I and the publishers of this article disown any liability on account of any loss or damage that may be caused on account of use of views expressed here.